The ECB has learned a lesson: surprisingly bad inflation data has been received

On an annual basis, inflation in the eurozone was 6.9% in March, which is a significant drop from February’s 8.5%. The decline in annual inflation was expected due to the higher base in March last year, and analysts even slightly underestimated the decline in annual inflation, with the Reuters consensus being 7.1%.

This in itself is good news, but looking at core inflation it quickly becomes clear that the situation is much worse.

The annual core inflation rate rose to 5.7% in March from 5.6% in February. Analysts expected an annual increase in the core inflation rate, and the consensus was 5.7%. The month-on-month increase is even more worrying: after increasing 0.8% in the previous month, prices rose 1.2% from February to March.

The core inflation basket does not include products with variable prices, such as food and energy, so it gives a more accurate picture of the underlying inflationary processes and better shows what kind of inflationary pressure from the demand side prevails in the economy (of course not quite, since energy prices affect a wide range of the economy , for example, seeps into prices for services and manufactured goods). In the present situation, when a large part of inflation is on the supply side, the development of core inflation is more important for the central bank.

While the core inflation indicator is declining due to lower energy prices, core inflation pressure is not abating and is well above the central bank’s 2% target. The ECB has so far raised interest rates by 350 basis points, most recently in March, and they have promised that more rate increases will follow if inflation makes it necessary.

From today’s data, we can infer that ECB decision makers – and especially recently they’ve been particularly vocal – will urge a rate hike. However, the situation is not so simple, because raising interest rates puts additional pressure on the banking system, while recently there have been concerns about a possible financial crisis after the failure of banks (Silicon Valley Bank, Signature, Credit Suisse).

The ECB has until May to consider: if there are no signs of a broader banking crisis by then, the cycle of rate hikes is likely to continue (of course, there will also be inflation data for April and May until then, which will also be taken into account during interest rate decisions). On the other hand, if loan payments drop significantly, there is no need for the central bank to raise them further, because a decrease in loan payments will also slow the economy, which will reduce inflationary pressure.

There is still a lot of uncertainty about the ECB’s future interest rate decision, and it can also be seen that the weight of the inflation data release in predicting the decision has decreased, because some indicators of the banking sector have played a role. Given the unclear picture, it is not surprising that the EUR did not move in response to today’s inflation data.

Cover image: Getty Images

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